Tuesday, September 30, 2008

"The agency that protects U.S. bank deposits is asking Congress for temporary authority to boost deposit insurance limits as the government works to contain the financial crisis.

Federal Deposit Insurance Corp. Chairwoman Sheila Bair on Tuesday asked for unspecified authority to raise insurance limits on the very day that both presidential candidates recommended the move as a way to help prospects for the failed $700 billion financial bailout bill."

Even as most US markets opened higher (was it over reaction or a new push for a bail out?), the news was still dominated by yesterday's news of the House blocking the bail out bill and the resulting market sell off. All of the major news providers covered the stock market drop. For instance from Business Week:

"The ugliness was widespread, with major indexes posting their worst percentage declines since the 1987 stock market crash. The Dow Jones Industrial average tumbled almost 7%, the S&P 500 sank 8.8%, and the Nasdaq plunged a jaw-dropping 9.1%. The Dow suffered its largest point drop in history."

There is no way to say that the drop was not large, but also shows how large the crash of 1987 was. (The Business Week article has a in interesting figure showing largest DOW price moves.)

More overlooked were some other market moves. For instance a spike in short term borrowing.

"The scramble for cash as banks sought to square their books over the end of the quarter saw the European Central Bank lend $30 billion dollars overnight at a huge rate of 11 percent -- more than five times the Federal Reserve's 2 percent target rate -- and call for bids for an additional $50 billion.

Meanwhile, the London interbank offered rate (Libor) for overnight dollars jumped by a record 430 basis points to 6.87 percent, the highest in at least 7-1/2 years."

Sunday, September 28, 2008

I am continually reminded in class how many college students know next to nothing about arguably the world's most famous investor. So when the WSJ's Wallet blog reported a few items on his personal finances, I jumped at the opportunity to send readers in that direction:

"...what are Buffett’s personal finances like? Our esteemed colleagues at Deal Journal have been tirelessly reporting on his deal-making psyche, so we thought we would round up some nuggets about his everyday spending.

-His net worth is around $62 billion (with a “B”), but he takes home a mere $100,000 as his annual salary as head of Berkshire Hathaway.-He still lives in the Nebraska home he bought four decades ago for $31,500."

There are several other tidbits there as well, including the observation that his credit score is lower than you would thing due to identity theft.

"Under the tentative deal being finalized, the rescue program would be overseen by a board including the treasury secretary, secretary of commerce, head of the Securities and Exchange Commission and chairman of the Federal Reserve, said Sen. Kent Conrad, R-North Dakota, who heads the Senate Budget Committee.

According to Conrad, $700 billion would be disbursed in stages, with $250 billion made available immediately. In addition, the Treasury would establish an insurance program -- with premiums paid by the industry -- to mitigate taxpayer losses. The bill would also probably include some curbs on the compensation of executives at companies that participate."

In an earlier piece, the WSJ has a good description of what the government will be doing in any of the proposed plans(essentially buying and then trying to resell at a later date):

" -- a key goal is to remove much of those soured mortgage securities from banks' books, possibly through an auction system.

The government -- taxpayers, essentially -- would then hold those assets until they can be sold off in a more normal market once the economy and housing market recover.

and later

"So taxpayers face the risk of losing some part of the $700 billion -- but could also turn a profit if the U.S. ends up selling those holdings for more than the purchase price."

and as the WSJ points out, previous deals such as Bear and AIG are structureed similarly, which means that while taxpayers do have a great deal invested, the actual cost of the deals is not known. Indeed, they could make a profit (which is unlikely given government track record of selling securities, but possible).

Wednesday, September 24, 2008

We can argue how much pure finance this is, but Thomas Friedman has a new book out. I have not even seen it, but was profiled in Salon. In it he suggests the industries and fields in which we should be investing. Now I have trouble with anyone telling me where people should be investing (the market will usually get it), but the interview is interesting and I am fairly sure I will be buying the book.

"The shortest way I can explain it is that 'hot' stands for the increase in global warming, 'flat' is my metaphor for the rise of middle classes all over the world, from India to China to Brazil to Russia, who are now able to consume and produce like Americans, and 'crowded' is the fact that the population of the planet in my lifetime ...has almost tripled."

and later:

"...the engine of this whole change is the market. We're not going to regulate our way out of this problem. We can only innovate our way out of it. But that requires rules. It requires legislators, Congress, to write different rules. "

Tuesday, September 23, 2008

Do you remember the old REM song "It's the end of the world as we know it"? Well they could have been singing about this past week in finance (except the feeling fine part maybe...). The latest manifestation is the news of yesterday that Morgan Stanley and Goldman Sachs begun the process to convert to a bank holding company. The move will bring them under the protection, but also the regulation, of the Fed.

"The move to convert to a commercial bank structure will help the two companies avoid the fates of Bear Stearns, Lehman Brothers and Merrill Lynch by giving them broader access to borrow federal money and the ability to build a stable base of deposits.

But it also likely means an end to the sky high profits that were topped by few other companies. The strict rules set by the Federal Reserve will limit opportunities for big payoffs from bets on the price of oil and other investments usually funded with borrowed money.

'The Fed is a much more intrusive regulator...experts expect smaller companies _ including private equity firms and hedge funds _ to take their place.

But even in the area of private equity this switch to a bank holding company may have large implications. For instance, investment bankers have been large players in Private Equity a practice that will likely end.

"Goldman has been a big investor in its own private-equity funds, and Morgan Stanley intended to be. Close to half of the capital in Goldman’s most recent, $20 billion buyout fund, for instance, came from the parent company and its employees. Morgan Stanley is expected to contribute about one-third of the capital to its new fund. But changing into bank holding companies may limit how much capital these banks are able to commit to their PE funds...."

"The move alters one of the models of modern Wall Street, the independent investment bank, soon after the federal government unveiled the biggest market intervention since the New Deal. It heralds new regulations and supervision of previously lightly regulated investment banks, as well as an end to the outsize paychecks that helped shape the image of the chest-thumping Wall Street banker."

The new classification will also affect the amount of leverage the firms can use. Again from the NY Times:

"The regulation by the Federal Reserve also brings a host of accounting rule changes that should benefit the two banks in the current environment. [ugh, I cringe when accounting rule changes are ever given as a reason for anything]

In return , they will submit themselves to greater regulation, including limits on the amount of debt they can take on. When it collapsed, Lehman had about a 30:1 debt-to-equity ratio, meaning it had borrowed $30 for every dollar in capital it held. Morgan Stanley currently has a debt-to-equity ratio of 30:1, while Goldman Sachs has one of about 22:1.

Bank of America, on the other hand, currently has about an 11:1 leverage ratio, while JPMorgan has about 13:1 and Citigroup about 15:1."

In cooperation with the American Finance Association (AFA), the Financial Economics Network (FEN) is pleased to announce the American Finance Association 2009 Meetings Abstracting eJournal. This abstracting eJournal is available to all subscribers at no charge and contains abstracts of the meeting papers with links to the full text within the SSRN eLibrary.

The purpose of this abstracting eJournal is to provide a data warehouse for all abstracts and papers presented at the meetings and to facilitate their distribution to the finance profession as a whole. Abstracts of the papers will also be distributed in subject-specific eJournals within the FEN Network and, where appropriate, in the journals of our sister networks.

You can browse all American Finance Association 2009 Meetings Abstracts in the SSRN database using the following link. There are currently more than 100 such papers in the system. You may wish to bookmark it in your browser.

Monday, September 22, 2008

ok, thanks for the concern folks, I am fine...just been on the road for a finance club trip, then a weekend in NYC (yes I saw a Yankee game), plus busy with BonaResponds local weekends weekends--we are building two homes--and a local wind storm downed trees and gave us some chain saw work.

Which is a long way of saying, I am back and ready to begin blogging again. In class today we reviewed the historic moves of the past week. I will try to get the summary of it up soon.

Wednesday, September 10, 2008

"A six-year-old article mistakenly seen by Bloomberg financial news users ....reported the bankruptcy of United Airlines and triggered a massive sell-off that nearly obliterated the company's stock in a matter of minutes.

The light-speed wipeout is a powerful reminder of how quickly bad information can spread via the Internet to a trigger-happy Wall Street that is willing to dump millions in stock before checking the facts.

It exposed the vulnerability of Bloomberg's influential brand name to bogus content."

This is a few days old, but we were talking about it in class and thought others might like it as well.

David Hirshleifer, a finance professor at the Paul Merage School of Business at the University of California, Irvine, says people have a natural tendency to like things with which they're familiar.

"We treat things we're used to as friends.""

Later:

"..a report released earlier this year by Citi found that a portfolio should have 25 to 30 stocks to minimize stock-specific risk. It found that only one in 10 stocks consistently outperformed the Standard & Poor's 500-stock Index over the past 20 years in any three-year period. Additionally, a third of the stocks in the index underperformed the overall market by at least 15% or more at any given year. Mr. Munshower says it isn't unusual for high net-worth and ultrahigh net-worth clients to have high concentrations of one stock in their portfolios. "It's very hard for people to sell a concentrated position...""

If there is one thing finance can teach us it is to diversify our investments. While diversification will not eliminate risk (systematic risk is still going to be a problem in most cases), diversification will reduce risk.

How important is diversification? It is the the second most important piece of investment advice I give my family and friends. The list?

Invest early and often to let compounding work in your favor.

Diversify! Across asset classes and across different investments. (remember not all investments are made in financial instruments-education is also an investment, so too is your health).

Transaction Costs matter: keep them low!

Make full use of any tax-advantaged plan.

Automate your savings so you do not need to worry about them. (also what you never had you will not miss).

"...for Cerberus, named after the mythological three-headed dog who guards the gates of hell, the news keeps getting worse.

On Wednesday, Chrysler, which owns the Jeep and Dodge brands, said its sales in the United States fell by a third in August ....The same day, GMAC, in which Cerberus holds a 51 percent stake, said it was trying to stanch the bleeding from a business that was supposed to be immune to the ups and downs of the car industry: home mortgage lending. GMAC and its home loan unit, Residential Capital, announced that they would dismiss 5,000 employees, or 60 percent of the unit’s staff, and close all 200 of its retail mortgage branches....

A Cerberus spokesman said in a statement on Wednesday that it remained confident in its management of Chrysler and GMAC. “No one is pleased with current market conditions,” he said. “However, Cerberus is a patient investor and not a market timer, and we take a long-term view of our investments. Our funds are structured accordingly.”

Class discussion questions: Some ideas for a class discussion.

1. What does this say about the limitations of diversification? Notice how even though Cerberus seemed diversified, bets that were at first glance uncorrelated (mortgages and car sales) both turned against them at the same time.

2. What does it say about long term vs short-term investment strategies. For instance the article states :

"Over the years, Cerberus excelled by gaining control of companies in bankruptcy and nursing them back to financial health....Top executives at Cerberus have said they are determined to fix the company and that their $7.4 billion investment will pay off.

What risks does a firm incur when holding onto an investment that turns bad? What is the risk of selling now? (i.e. losing out on return if they turn it around). Can you think of anything from own life that was like that?

3. Upper level class? try this. What does this type of strategy suggest about returns to private equity funds? How is this related to the "survivorship" bias problem?

SBU note: the on campus fitness center is in large part the result of a multi-million dollar donation by Bill Richter who is a founding partner of Cerberus, so there is a higher degree of interest in Cerberus on campus.

Wednesday, September 03, 2008

"Tumbling commodities prices have claimed a big victim. Ospraie Management is shuttering its biggest hedge fund after a 27% plunge last month, The Wall Street Journal reports, following a series of wrong-way bets on oil and natural gas, among others. The fund, run by Julian Robertson disciple Dwight Anderson has been selling off its holdings over the past three weeks, the paper reports. At its height last year, the fund had $3.8 billion in assets."

Given it is the start of the school year, a concentration on basics may be called for so if you are not totally sure what a hedge fund is, and even if you just want to have another look, here is the Wikipedia entry that is interesting and has some details (if true, hey it is Wikipedia) that even so-called experts may benefit from a read. For instance it has a nice description of the various forms of funds, on the size and flow of funds, and on their pay plans.

The president of the Federal Reserve Bank of Kansas City, Thomas M. Hoenig, said on Monday that for economies to work best, institutions must be allowed to fail.

Economies must “find a balance between financial stability and a stable price environment and in doing so must be able to allow individual institutions to fail....”"

Which is what anyone would say, but then do we let the institution actually fail when it does get into trouble? If the prospect of such failure is missing, there is an increased moral hazard problem where institutions take on larger and larger risks while allowing the government to hold the cards of a losing hand.